Question

Financial information for American Eagle is presented in Appendix A at the end of the book, and financial information for Buckle is presented in Appendix B at the end of the book.

 

Required:

1. Calculate the current ratio for both companies for the year ended February 3, 2018. Which company has the better ratio? Compare your calculations with those for United Airlines and American Airlines reported in the chapter text. Which industry maintains a higher current ratio?

2. Calculate the acid-test (quick) ratio for both companies for the year ended February 3, 2018. Which company has the better ratio? Compare your calculations with those for United Airlines and American Airlines reported in the chapter text. Which industry maintains a higher acid-test ratio?

3. How would the purchase of additional inventory with accounts payable affect the current ratio for these two companies?

Answer 1

Current ratio:

It is the ratio determined by keeping the current assets and current liabilities as the basis of determination. The ideal current ratio of the company is 2:1. 2 determine the current assets of the company and 1 determines the current liabilities of the company. It should not be less than one. The current ratio is calculated by dividing the current assets with current liabilities. The following is the formula to calculate the current ratio:

Current ratio = Current assets/Current laities

 

Acid-test ratio:

This is the ratio used to measure the ability in terms of liquidity of a company to pay its current obligations using its quick assets only. Quick assets are those assets that can be converted into cash within 90 days or in a shorter period. The following is the formula to calculate the acid-test ratio:

Acid-test ratio = Quick assets/Currents liabilities

 

(1)

Calculate the current ratio for both the companies:

Refer to the consolidated balance sheets of AE Company and B Company for the years ended 2018, the current ratio is calculated by dividing the total current assets with total current liabilities. 

Particulars	AE Company ($000’s)	B Company ($ 000’s)
Total current assets (a)	968,530	360,584
Total current liabilities (b)	485,221	97,906
Current ratio (a ÷ b)	2.00	3.68

 

Hence, the current ratios of AE Company and B Company for the year ending February 3, 2018 are 2.00 and 3.68 respectively.

 

 

As explained above, the higher the current ratio, the higher is the ability of a company to repay its current liabilities using its current assets. From the above explanation, it is clear B Company has the better current ratio of 3.68 than the current ratio of AE Company 2.00.

 

When the current ratios of both the companies are compared to the industry, both the companies have the better current ratios than the industry.

 

(2)

Calculate the quick ratio for both the companies:

Refer to the consolidated balance sheets of AE Company and B Company for the years ended 2018, the quick ratio is calculated by dividing the total current assets with total current liabilities. 

Particulars	AE Company ($000’s)	B Company ($ 000’s)
Quick assets:
Cash and cash equivalents	413,613	165,086
Accounts receivable	78,304	8,588
Short-term investments		50,833
Total quick assets (a)	491,917	224,507
Total current liabilities (b)	485,221	97,906
Quick ratio (a ÷ b)	1.01	2.29

 

 

Hence, the quick ratios of AE Company and B Company for the year ending February 3, 2018 are 1.01 and 2.29 respectively.

 

As explained above, the higher the quick ratio, the higher is the ability of a company to repay its current liabilities using its quick assets. From the above explanation, it is clear B Company has the better quick ratio of 2.29 than the quick ratio of AE Company 1.01.

When the quick ratios of both the companies are compared to the industry, both the companies have the better quick ratios than the industry.

 

(3)

The current ratio of AE Company and B Company is more than 1.0. So, the purchase of additional inventory with accounts payable will decrease the current ratio of these two companies.

In contrast, the current ratio of U Airlines and A Airlines is less than 1.0. So, the purchase of additional inventory with accounts payable will increase the current ratio of these two companies.

(1)

Hence, the current ratios of AE Company and B Company for the year ending February 3, 2018 are 2.00 and 3.68 respectively.

(2)

Hence, the quick ratios of AE Company and B Company for the year ending February 3, 2018 are 1.01 and 2.29 respectively.